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Why I prefer the Lloyds dividend to the Rolls-Royce share price

A Rolls-Royce employee works on an engine
Image: Rolls-Royce

When searching for bargains in the FTSE 100, a number of blue-chip names pop out. While the recent Rolls-Royce (LSE: RR) share price rise means that the engineer is no longer a penny stock, that’s not true for bank Lloyds (LSE: LLOY).

Right now I would rather have Lloyds in my portfolio for its dividend than Rolls-Royce for any potential capital gain. Here’s why.

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Dividends as passive income

Dividends can make an excellent source of passive income. While I don’t always go for income stocks, dividend potential is a consideration for me a lot of the time.

Dividends are never guaranteed: neither Lloyds nor Rolls-Royce made payouts last year, for example. But while in the case of Lloyds that was due to a regulatory constraint, for Rolls-Royce it was because the company needed to shore up liquidity.

Fast forward to today and Lloyds has restored its dividend. So far this year, its interim dividend of 0.67p might not sound like anything to write home about. But given its penny share status, that dividend alone equates to an annual yield of 1.5%. If the bank returns to its prior policy of the interim dividend representing around one third of the total annual payout, that suggests a forward yield of 4.5%.

By contrast, Rolls-Royce continues to pay no dividend. Indeed, the conditions on a loan it has drawn mean it cannot pay any dividends until 2023 at the earliest. Even then, dividends aren’t assured. That is true for Lloyds too – no dividend is ever guaranteed. An increase in bad loans could hurt Lloyds’ profit and make it cut its dividend again, for example. But currently from a dividend perspective, I would feel much happier having Lloyds in my portfolio than Rolls-Royce.

The Rolls-Royce share price as a possible source of gain

However, dividends aren’t the only game in town. It’s also possible for an investor like myself to benefit from share price appreciation. The Lloyds share price has increased 62% over the past year and Rolls-Royce has gained 50%. I’d have welcomed either result with open arms.

I think there is further possible upside for both shares. If Lloyds can continue to record bumper profits – its statutory profit in the first half was £3.9bn – I think it could boost the bank’s share price. Meanwhile, at Rolls-Royce, increasing demand for air travel could boost both revenues and profits. Additionally, the company’s anticipated return to free cash flow positivity in the current half-year period could boost the Rolls-Royce share price. That’s because it would help to allay liquidity concerns.

However, if aviation demand stalls or the cash flow target isn’t met, there is a risk the Rolls-Royce share price could fall. But Lloyds faces risks too. For example, its foray into becoming a landlord could hurt its profitability.

My next move

I do see potential for appreciation in the Rolls-Royce share price. But for now I plan to hold my Lloyds shares without adding Rolls-Royce to my portfolio. That’s for two reasons. First, the dividend prospects for Lloyds in the next several years seem much better. Secondly, Lloyds has had a strongly performing business but Rolls-Royce remains a turnaround story. Either could make a misstep, but there’s often less room for error in a turnaround situation.

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Christopher Ruane owns shares in Lloyds Banking Group. The Motley Fool UK has recommended Lloyds Banking Group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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